Fed in focus in year’s finale

A perspective from E*TRADE Securities 12/17/20

On December 16, the Federal Open Market Committee—the policy-making arm of the Federal Reserve—concluded its final meeting of 2020, indicating interest rates could remain anchored near zero through 2023. 

Why does this matter? Because the Fed essentially sets the nation's borrowing rates—for everyone from major corporations to main street consumers. Near zero rates means it’s cheaper to borrow money, which the Fed hopes will help reignite the economy.

The Fed’s response to the events of the past year have been extraordinary: slashing the benchmark interest rate by 150 basis points in the span of two weeks, buying up an unprecedented amount of Treasuries and expanding purchases to include corporate bonds and exchange-traded funds, and extending its lending programs to main street businesses and state and local governments. It also ushered in a new era when it adjusted its approach to managing inflation, announcing it would allow the economy to run hotter for longer before cooling it down by hiking rates.

However, the central bank may still have its work cut out for it in 2021, especially as the shorter-term hardships of the COVID crisis weigh on a longer-term outlook buoyed by the prospect of vaccine distribution. 

The dual mandate

The Federal Reserve’s primary goals are promoting price stability and maximum employment—in other words, managing inflation and keeping unemployment down. 

Inflation has been running below the Fed’s 2% target for the better part of the last decade. However, some analysts anticipate higher inflation may be a defining factor of the next business cycle, considering the amount of stimulus unleashed to help prop up the economy this year.

Source: Federal Reserve Economic Data (FRED)

Meanwhile, the unemployment rate remains well above pre-pandemic levels, albeit down significantly from its 14.7% peak in April. But job gains have slowed in recent months and the latest jobs report missed estimates by a mile. The number of new jobs in November came in at 245,000—nearly half what analysts had been looking for, and roughly a third of October’s gains. While the unemployment rate ticked down to 6.7% from 6.9%, the labor participation rate dropped with it.1 

Source: US Bureau of Labor Statistics

Fed outlook

Minutes from the FOMC’s November meeting revealed the committee was considering adjusting the bond-buying program it uses to pump extra liquidity into the economy. For now, though, policymakers appear comfortable with the current pace and scope of purchases, saying it would maintain the program “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”2 

The committee also revised its economic forecasts for next year, reflecting a slightly more optimistic outlook for GDP (4.2% growth for 2021 vs. 4% previously), and a considerable improvement in labor market conditions (5% unemployment rate vs. 5.5% previously).2 

Looking ahead

After playing a leading role in both the economic and market recoveries, the Fed won’t fade into the background anytime soon. In his comments following the latest meeting, Chairman Jerome Powell again stressed that the Fed is fully committed to using all the tools at its disposal to help the economy to and through pre-pandemic levels.      

Here are a few factors that may spur action from the central bank in 2021:

  • Vaccine progress: The narrative has shifted from getting a vaccine approved, to getting it widely distributed. The course of the rollout may affect the Fed’s economic outlook and its timeline for future policy decisions.
  • Weak economic data: After rebounding sharply in the third quarter, economic activity has cooled. The November retail sales number was latest data point indicating a slowdown, falling for a second-straight month.3
  • Inflation: While inflation is currently low, our colleagues at Morgan Stanley4 believe it may be poised to surprise on the upside, and may quickly overshoot the Fed’s target next year.

The Federal Open Market Committee is next scheduled to meet January 26–27. While uncertainty may linger for the next few weeks as the country wrestles with a brutal virus resurgence, there is a light at the end of the tunnel amid vaccine rollouts. Remember to stay the course and keep investing decisions focused on individual timelines, long-term goals, and risk tolerance.

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  1. CNBC, “Employment growth slows sharply in November amid coronavirus surge,” 12/4/20, https://www.cnbc.com/2020/12/04/jobs-report-november-2020.html
  2. CNBC, “Fed commits to keep buying bonds until the economy gets back to full employment,” 12/4/20, https://www.cnbc.com/2020/12/16/fed-decision-december-2020-fed-commits-to-keep-buying-bonds-until-the-economy-gets-back-to-full-employment.html 
  3. CNBC, “U.S. retail sales decrease more than expected in November,” 12/16/20, https://www.cnbc.com/2020/12/16/us-retail-sales-november-2020.html
  4. E*TRADE Financial, LLC is a business of Morgan Stanley.

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